FSMZX Franklin Strategic Mortgage Portfolio

Dividends paid by a fund that are derived from interest, dividends, net short-term capital gains and other types of ordinary income earned by the fund. For a fund that elects to pass through its foreign taxes paid (a non-cash item), a shareholder's allotted share of foreign taxes has been added to the “Ordinary Dividends” cash distributions received by the shareholder. If the fund passed through foreign taxes paid and later is refunded any portion of those taxes by a foreign tax authority, any interest paid to the fund on that refund is also required to be included in “Ordinary Dividends”.

The portion of a fund’s “Ordinary Dividends” that may be eligible for a reduced capital gain tax rate. To be eligible for the lower tax rates, certain holding periods apply and shareholders should consult their tax advisor to determine the amount eligible for the reduced rate. This amount represents both cash distributions and non-cash amounts, such as foreign taxes paid, that have been allocated to shareholders.

The net long-term gains recognized by a fund from the sale of securities and other assets. These distributions may be eligible for a reduced capital gain tax rate.

The portion of a fund’s “Capital Gain Distributions” related to certain depreciable real property—typically derived from a fund’s real estate investment trusts holdings. Unrecaptured section 1250 gains are usually taxed at a higher tax rate than general “Capital Gain Distributions”.

Also known as a “Return of Capital”, occurs when a shareholder receives a portion of their investment that is not considered income or capital gains. These amounts are not taxed currently but may reduce the cost basis of the shares related to the distribution.

The portion of a fund’s “Ordinary Dividends” generated by a real estate investment trust or earned by a fund from its investments in real estate investment trusts, subject to limitations. Individual (non-corporate) shareholders may be entitled to a special deduction from gross income for “Section 199A Dividends” received from a fund. To qualify for this deduction certain holding periods apply and shareholders should consult their tax advisor.

Shareholder’s pro-rata portion of foreign taxes paid by the fund to non-US tax authorities. A shareholder may be eligible to claim these as a credit or take a deduction on their tax return and should consult their tax advisor.

Represent the net tax-exempt income earned by the fund from municipal bonds and other tax-exempt securities. This income is typically not subject to federal income tax but may be subject to state and or alternative minimum tax. Shareholders should consult their tax advisor if they have any questions.

Interest paid by European countries on historical overwithholding of taxes by the foreign governments related to dividends and interest paid to the mutual fund. The reclaimed taxes are now being refunded as a result of various court rulings. In accordance with IRS Notice 2016-10, the mutual fund is required to report the interest on the reclaimed taxes on Form 1099-DIV